Blame small government for U.S. GDP downer

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Weak U.S. economic growth in the first quarter was driven in part by a pullback in business investment — but a sharp decline in government spending also played a role. Gross domestic product grew 2.2 percent, well short of the Reuters consensus forecast of 2.5 percent. Business spending fell 2.1 percent while government expenditures saw a 3 percent drop linked to lower defense spending. Consumer spending proved a bright spot in the report, climbing 2.9 percent. Still, there is concern that this too could fade because an unusually warm winter may have brought some spending forward.

Jay Feldman at Credit Suisse breaks down the numbers:

The big downside surprise from our vantage point was in federal government spending, which contracted 5.6% in the quarter (we expected an increase given the firmer readings in monthly Treasury data). Most of the shortfall was concentrated in defense (-8.1%). Combined with the ongoing contraction in state and local government output (-1.2%), the government sector overall shaved 0.6 percentage point from top line GDP.

Yet this pales in comparison to what might happen if Congress fails to break a budget logjam by the end of this year. If left unaddressed, the resulting spending cuts and expiring tax breaks — the dreaded fiscal cliff — could easily tip the world’s largest economy back into recession.